Earnings Season Kicks Off
“Anything I wanted to know, any place I needed to go” has been the market’s mantra for nearly a year. While the song remains the same, the economic data and earnings also remains the same. As we start to see improvement in a few economic reports, others weaken. Central Banks continue to push on the liquidity lever, believing that flooding the globe with cash will miraculously generate inflation and economic growth. After eight years, little has changed. Interest rates remain near zero and below zero in a variety of countries. Economic growth in the US has been steady at roughly 2.25% annually since 2009, about the same as it has over the past three years. There is more handwriting as earnings season is once again upon us with expectations for another decline in quarterly earnings. After peaking early in 2015, earnings have declined by 18% since. Little wonder that stocks have struggled to rise over that same time. This week is a bit light
for earnings, but we will see over the coming weeks just how much revenue growth companies are able to generate. With Fed officials chatting nearly every day this week, I’m thinking we already know what they will be saying and where the markets will be going. It is the same old song and dance.
One of the ways to see the overall health of the market is to look at just the operating companies on the New York exchange, which excludes funds, preferred stocks and other derivative securities. This focuses on “real” companies, with products, sales and earnings. When looking at those that trade higher from one day to the next vs. those that trade lower, we can gauge whether the markets are “healthy” (lots of stocks rising) or “weak” (more falling than rising). Since the market peak of May ’15, there has been a persistent decline in this daily gauge, indicating that the troops are not following the averages higher. If we narrow the view to just the companies in the SP500, we see this has increased dramatically since early February. This is not the case for smaller stocks, where the recent advance has not taken as many stocks along for the ride. This can be best defined as “bad breadth”, when the popular averages are doing much better than the average stock. Eventually either the averages catch up to average stock or vice versa. Based upon the weakness in earnings and relatively poor economic growth, our best guess is that the averages start to perform more in line with the average stock than the other way around. Throw the elections on top and the rest of the year could be really interesting! Interest rates in the US continue to press lower, even though the Fed would like to begin raising them more aggressively than just once. The Fed is looking for stronger economic activity to justify further rate increases.
But the relatively low global inflation rates and near negative rates in many countries is pushing investors to the relatively high rates and safety of Treasuries. The bond model continues to point to lower rates ahead, as it has rather consistently for the past 20 years. There used to be year-long periods of rising rates, however over the past eight years, those periods of rising rates have been confined to merely a quarter or so. While the cover of Barron’s highlights Bill Gross’ belief that rates have to rise, without faster economic growth and persistently higher inflation, rates are likely to stay lower for longer than many are ready to believe today.
If you were told energy stocks would be positive this year and health care and financials would be the worst, you might be more than just a little surprised. The really big winners are the very interest rate sensitive sectors, with utilities, telecom and REITs all up over 5%. As long as interest rates are heading for the basement, investors will be trying to find alternatives to get income. The main difference between higher yielding stocks and (treasury) bonds is that bonds have a certain value at maturity, so returns can be calculated with certainty. Stocks have no such certainty and can decline erasing any income “benefit” they may have today. The low rate environment is pushing the valuation of these higher yielding stocks to historically high levels. Even a 25% decline would make them look just expensive. Looking outside of the US, valuations are much lower in many emerging market countries, like Russia, Brazil and Egypt. Similar to early last year, we are seeing these markets pop, only to see them rollover as the weather warmed in the US. We’ll see if this year is any different.
The best opportunities continue to be in emerging markets; however they remain very volatile and generally hurt by lower energy prices. If we can see some stabilization over the coming months in this part of the market, we are likely to dip our toes into the swirling waters. For now we remain cautious, under-weighting stocks vs. bonds and expecting the markets to remain volatile with 100+ point swings similar to the past few months.
The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present orfuture financial market conditions.